Friday, April 03, 2009

Simon Johnson and James Kwak argue that Ben Bernanke is "radically redefining
his institution," and that his "willingness to pump money into the economy risks
unleashing the most serious bout of U.S. inflation since the early 1980s, in a
nation already battered by rising unemployment and negative growth."

This is, in essence, a question about whether inflation expectations are
anchored or not, and that is also the key question is
this discussion of the odds of deflation by John Williams of the SF Fed. He
argues that the previous decades can be broken into a recent time period in
which expectations appear to be well-anchored, the time period 1993 through 2008
is cited in the
linked discussion, and a time period in the late 1960s and the 1970s when
inflation expectations do not appear to be anchored (based upon Orphanides and
Williams 2005). The paper also notes that recent surveys of professional
forecasters are consistent with anchored expectations.

But past history shows us that expectations can move from one state to the
other, from untethered to tethered, and there's no reason that cannot happen
again, but in the other direction. So here
I
agree with Martin Wolf, it's dependent upon the credibility of policymakers.
So long as people believe that the Fed is committed to preventing an outburst of
inflation, and that they are capable of carrying through on that commitment,
expectations will remain well-anchored. But if people believe that that Fed's
hands are tied because of the harm reducing inflation would bring to the real
economy, an out of control deficit, or due to political considerations that
force them to accept inflation they could and would battle otherwise, then we
have a different situation and long-run inflation expectations will change
accordingly.

So there is nothing at all - except the credibility of the central bank -
that guarantees expectations will remain anchored. I still believe that the Fed
can and will prevent an inflation problem from developing, and I am
notalone, but there are
respected
analysts who see it otherwise, or who are at least very worried, and that means the public can't be too far
behind (the original is quite a bit longer,
and explains the argument in more detail):

The Radicalization of Ben Bernanke, by Simon Johnson and James Kwak, Commentary,
Washington Post: Timothy Geithner and his predecessor Henry Paulson have
been the public faces of the U.S. government's battle against the global
economic crisis. But even as the secretaries of the Treasury have garnered the
headlines -- as well as popular anger surrounding bank bailouts and corporate
bonuses -- another official has quickly amassed great influence by committing
trillions of dollars to keep markets afloat, radically redefining his
institution and taking on serious risks as he seeks to rescue the American
economy. Without a doubt, this crisis is now Ben Bernanke's war.

Bernanke has become the country's economist in chief, the banker for the
United States and perhaps the world, and has employed every weapon in the
Federal Reserve's arsenal. He has overseen the broadest use of the Fed's powers
since World War II, and the regulation proposals working their way through
Congress seem likely to empower the institution even further. Although his
actions may be justified under today's circumstances, Bernanke's willingness to
pump money into the economy risks unleashing the most serious bout of U.S.
inflation since the early 1980s, in a nation already battered by rising
unemployment and negative growth.

If he succeeds in restarting growth while avoiding high inflation, Bernanke
may well become the most revered economist in modern history. But for the
moment, he is operating in uncharted territory. ...

In short, Bernanke is making the biggest bet placed by a U.S. central banker
in decades, wagering that he can pull the economy out of a deep crisis by
creating money without unleashing high and long-lasting inflation.

Will it work? In a normal advanced economy, creating hundreds of billions of
dollars in new money would not foster runaway inflation. As long as the economy
is underperforming ... stimulating the economy will only cause that "slack" to
be taken up, the theory goes. Only when unemployment is low again can workers
demand higher wages, forcing companies to raise prices.

But is the United States really a normal advanced economy anymore? We seem to
have taken on some features of so-called emerging markets, including a bloated
(and contracting) financial sector, overly indebted consumers, and firms that
are trying hard to save cash by investing less. In emerging markets there is no
meaningful idea of "slack;" there can be high inflation even when the economy is
contracting or when growth is considerably lower than in the recent past.

If the United States is indeed behaving more like an emerging market,
inflation is far easier to manufacture. People quickly become dubious of the
value of money and shift into goods and foreign currencies more readily. Large
budget deficits also directly raise inflation expectations. This would help
Bernanke avoid deflation, but there is a great danger that unstable inflation
expectations will become self-fulfilling. We do not want to become more like
Argentina in 2001-2002 or Russia in 1998, when currencies collapsed and
inflation soared. ...

Bernanke, the soft-spoken but authoritative academic, has redefined the
Federal Reserve on the fly and exercised powers that Greenspan never dared
touch. Bernanke's strategy is risky, and only time will determine whether he is
being brave in averting a larger crisis, or reckless in unleashing inflation
that could increase quickly and uncontrollably. Today, Bernanke's gamble looks
like the worst possible alternative, apart from all the others.

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Inflation and the Fed

Simon Johnson and James Kwak argue that Ben Bernanke is "radically redefining
his institution," and that his "willingness to pump money into the economy risks
unleashing the most serious bout of U.S. inflation since the early 1980s, in a
nation already battered by rising unemployment and negative growth."

This is, in essence, a question about whether inflation expectations are
anchored or not, and that is also the key question is
this discussion of the odds of deflation by John Williams of the SF Fed. He
argues that the previous decades can be broken into a recent time period in
which expectations appear to be well-anchored, the time period 1993 through 2008
is cited in the
linked discussion, and a time period in the late 1960s and the 1970s when
inflation expectations do not appear to be anchored (based upon Orphanides and
Williams 2005). The paper also notes that recent surveys of professional
forecasters are consistent with anchored expectations.

But past history shows us that expectations can move from one state to the
other, from untethered to tethered, and there's no reason that cannot happen
again, but in the other direction. So here
I
agree with Martin Wolf, it's dependent upon the credibility of policymakers.
So long as people believe that the Fed is committed to preventing an outburst of
inflation, and that they are capable of carrying through on that commitment,
expectations will remain well-anchored. But if people believe that that Fed's
hands are tied because of the harm reducing inflation would bring to the real
economy, an out of control deficit, or due to political considerations that
force them to accept inflation they could and would battle otherwise, then we
have a different situation and long-run inflation expectations will change
accordingly.

So there is nothing at all - except the credibility of the central bank -
that guarantees expectations will remain anchored. I still believe that the Fed
can and will prevent an inflation problem from developing, and I am
notalone, but there are
respected
analysts who see it otherwise, or who are at least very worried, and that means the public can't be too far
behind (the original is quite a bit longer,
and explains the argument in more detail):

The Radicalization of Ben Bernanke, by Simon Johnson and James Kwak, Commentary,
Washington Post: Timothy Geithner and his predecessor Henry Paulson have
been the public faces of the U.S. government's battle against the global
economic crisis. But even as the secretaries of the Treasury have garnered the
headlines -- as well as popular anger surrounding bank bailouts and corporate
bonuses -- another official has quickly amassed great influence by committing
trillions of dollars to keep markets afloat, radically redefining his
institution and taking on serious risks as he seeks to rescue the American
economy. Without a doubt, this crisis is now Ben Bernanke's war.

Bernanke has become the country's economist in chief, the banker for the
United States and perhaps the world, and has employed every weapon in the
Federal Reserve's arsenal. He has overseen the broadest use of the Fed's powers
since World War II, and the regulation proposals working their way through
Congress seem likely to empower the institution even further. Although his
actions may be justified under today's circumstances, Bernanke's willingness to
pump money into the economy risks unleashing the most serious bout of U.S.
inflation since the early 1980s, in a nation already battered by rising
unemployment and negative growth.

If he succeeds in restarting growth while avoiding high inflation, Bernanke
may well become the most revered economist in modern history. But for the
moment, he is operating in uncharted territory. ...

In short, Bernanke is making the biggest bet placed by a U.S. central banker
in decades, wagering that he can pull the economy out of a deep crisis by
creating money without unleashing high and long-lasting inflation.

Will it work? In a normal advanced economy, creating hundreds of billions of
dollars in new money would not foster runaway inflation. As long as the economy
is underperforming ... stimulating the economy will only cause that "slack" to
be taken up, the theory goes. Only when unemployment is low again can workers
demand higher wages, forcing companies to raise prices.

But is the United States really a normal advanced economy anymore? We seem to
have taken on some features of so-called emerging markets, including a bloated
(and contracting) financial sector, overly indebted consumers, and firms that
are trying hard to save cash by investing less. In emerging markets there is no
meaningful idea of "slack;" there can be high inflation even when the economy is
contracting or when growth is considerably lower than in the recent past.

If the United States is indeed behaving more like an emerging market,
inflation is far easier to manufacture. People quickly become dubious of the
value of money and shift into goods and foreign currencies more readily. Large
budget deficits also directly raise inflation expectations. This would help
Bernanke avoid deflation, but there is a great danger that unstable inflation
expectations will become self-fulfilling. We do not want to become more like
Argentina in 2001-2002 or Russia in 1998, when currencies collapsed and
inflation soared. ...

Bernanke, the soft-spoken but authoritative academic, has redefined the
Federal Reserve on the fly and exercised powers that Greenspan never dared
touch. Bernanke's strategy is risky, and only time will determine whether he is
being brave in averting a larger crisis, or reckless in unleashing inflation
that could increase quickly and uncontrollably. Today, Bernanke's gamble looks
like the worst possible alternative, apart from all the others.